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Corporate Financial Management 3e Emery Finnerty Stowe

Introduction and Overview

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Learning Objectives

Define the field of finance and its areas.Describe major types of corporate financial

management decisions.Compare three major types of business

organizations.Compare and contrast three models of the

firm.Understand the objective of the firm.

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Chapter Outline

1.1 What Is Finance?1.2 Ownership, Control, and Risk1.3 Three Different Views of the Firm1.4 The Role of the Corporation1.5 The Evolution of Finance1.6 A Few Words of Advice

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What is Finance?

Determining value.

Value = What something is worth now.

Making the best decision when that decision involves money.

Finance is concerned with:

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How do we use corporate resources efficiently to further the goals of the firm?

Decisions are based on The Principles of Finance

Corporate Financial Management

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The Science of Finance

Finance is a science.Like other sciences, it has fundamental

concepts, principles, and theories.In Chapter 2, we describe the Principles of

Finance.

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The Art of Finance

In some situations, precise models cannot be created.

That does not mean that we cannot make decisions in these situations.

People may refer to using intuition to make decisions.

Decision makers are often using intuition from the Principles of Finance.

They are using scientific valuation concepts, but not exact numbers.

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Three Types of Decisions

Investment Decisions What assets should the firm invest in?

Financing Decision How should the purchase of assets be financed?

Managerial Decisions How large should the firm be? How fast should it grow? Should the firm grant credit to a customer? How should the managers be compensated?

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Financial Markets and Intermediaries

The study of markets where financial securities (such as stocks and bonds) are bought and sold.

The study of financial institutions (such as commercial banks, investment banking firms, and insurance companies) that help the flow of money from savers to demanders of money.

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Investments

The study of financial transactions from the investors outside the firm.

Examples include: How do we place a dollar value on a share of

stock or a bond issued by the corporation? How do we assess the risk of these financial

securities? How do we manage a ‘portfolio’ of financial

securities to achieve a stated objective of the investor?

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The Corporate Form of Organization

Ownership The shareholders (also known as stockholders or

equityholders) are the owners of the corporation. Control

Ultimate control rests with the shareholders, but the managers control the day-to-day operations.

Risk Bearing While all parties associated with the corporation

bear the risk, shareholders bear all residual risk.

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Advantages of Corporate Form of Organization

Limited LiabilityPermanencyTransferability of OwnershipBetter Access to Capital Markets

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Rights of Ownership

Dividend RightsVoting Rights

Majority voting one vote per share per director cannot combine votes

Cumulative voting directors are voted on jointly can cast all votes for a single candidate

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Rights of Ownership (continued)

Liquidation Rights Owners have the right to a proportional share

of the firm’s residual value in the event of liquidation, after other senior claims are paid.

Preemptive Rights Owners have the right to subscribe

proportionally to any new shares issued by the firm.

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The Goal of the Firm

Between defined than profitsConsiders timing of profitsConsiders risk differences among

alternative courses of action

“Maximize Shareholder Wealth”

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Henry Ford’s Fictionalized Firm

Organized as a sole proprietorship. Henry Ford is the sole owner of the firm. He has full control over the firm. He bears all of the risk.

Cash $CRaw Material $RTools $TGarage $G Total Assets $TA

Henry’s Equity $HE Liabilities & Owner’s Equity $TA

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Henry Ford’s Fictionalized Firm

Henry’s firm after the bank loan. Henry Ford is the sole owner of the firm. He has full control over the firm. Some risk is borne by the bank. He bears all of the remaining (residual) risk.

Cash $C’Raw Material $R’Tools $T’Garage $G’ Total Assets $TA’

Bank Loan $B’Henry’s Equity $HE’ Liabilities & Owner’s Equity $TA’

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Henry Ford’s Fictionalized Firm

Henry’s firm after going public. Henry shares ownership with new (outside) shareholders. Henry’s actions constrained by bank and other

shareholders. Bank continues to bear some risk. All shareholders bear residual risk.

Cash $C”Raw Material $R”Tools $T”Garage $G” Total Assets $TA

Bank Loan $B”New Shareholder’s Equity $O”Henry’s Equity $HE Liabilities & Owner’s Equity $TA

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The Investment Vehicle Model of the FirmInvestors provide financing to the firm in

exchange for financial securities.Firm invests these funds in assets.Income generated by the firm is distributed

to the investors.Managers act in the best interest of the

shareholders, and take actions to maximize shareholder wealth.

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The Firm as an Investment Vehicle

Investments

The Firm

Investment Decisions

Financing Decisions

Corporate Financial Management

Financial Markets and Intermediaries

Three Main Areas of Finance:

TheWorld

Exchange of Money and Real Assets

Investors

FinancialIntermediaries

FinancialMarkets

Exchange of Money and

Financial Assets

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The Accounting Model of the Firm

Balance sheet view of the firm.Investment decisions are represented on the

asset (i.e. left hand) side of the balance sheet.Financing decisions are represented on the

liabilities and equity (i.e. right hand) side of the balance sheet.

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The Accounting Model of the Firm: A Balance Sheet

The Financing Decision

Current LiabilitiesAccounts PayableCurrent Debt

Long-Term LiabilitiesLong-Term Bank DebtBonds

Shareholder’s EquityCommon StockRetained Earnings

The Investment Decision

Current AssetsCashMarketable SecuritiesAccounts ReceivableInventory

Total Fixed AssetsTangible Fixed AssetsIntangible Fixed Assets

Net Working Capital =CA - CL

Total Assets = Liabs. + O.E.

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Set of Contracts Model of the Firm

The firm has contracts with a large number of stakeholders.

These contracts may be explicit or implicit.Contracts may also be contingent on

particular future outcomes.The model recognizes that conflicts of

interest may exist between the various stakeholders.

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Set of Contracts Model of the Firm

PreferredStockholders

Managers

The FirmCommonStockholders

Communities

Creditors

Governments

Customers

Suppliers

Society

Banks

Environment

Bondholders

Employees

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The Evolution of Finance

Globalization Every firm operates in a global marketplace. Financial markets transcend national boundaries.

Technology Information can be readily obtained / disseminated. Need to use computing technology to maintain a

competitive edge. Corporate Reorganization and Restructuring

Your first job will not be the job you retire from.

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A Few Words of Advice

If you understand the “first principles,” every problem and issue can be solved using these principles.

Learn the principles not the specific solutions that you see along the way.

Buy a financial calculator.